Ackman Stains P&G Credit

Swaps move higher on fears activist investor will favor shareholders over bondholders.

Traders are pushing derivatives linked to Procter & Gamble Co. debt to the riskiest level relative to Colgate-Palmolive Co. and lower-rated Unilever since 2009 on concern that investor Bill Ackman will pressure the company to reward shareholders at lenders’ expense.

The cost to protect bonds of the world’s largest consumer-goods maker from default has increased 10.2 basis points to 0.62 percentage point yesterday in New York since July 11, after Ackman bought a $1.8 billion stake in P&G. While the stock has since gained 5.6 percent as bullish options wagers surge, bonds of the maker of Tide, Pampers and Crest are underperforming as profit margins narrow and sales growth decelerates to the slowest since 2009.

Ackman may persuade management to reinstate its share repurchase program with debt-sale proceeds, according to bond research firm Gimme Credit LLC, after its stock fell almost 10 percent from the 2012 high. Cincinnati-based P&G’s swaps were less expensive than those of Colgate and Unilever a year ago.

“It’s obviously a concern,” said Alan Shepard, a fixed-income analyst at Madison Investment Holdings Inc., which oversees about $16 billion and holds P&G bonds. Ackman has a history of “wanting to release shareholder value without too much concern from where the bondholders stand,” he said in a telephone interview from Madison, Wisconsin.

Credit-default swaps on P&G debt are up from this year’s low of 48 basis points on April 3, according to prices compiled by Bloomberg. It now costs about $62,000 annually to protect $10 million of P&G debt, the most since July 2009. Swaps linked to Colgate traded at 44 basis points today with contracts on Unilever at 35.

P&G obligations have also trailed the returns of AA rated corporate debt with board members dissatisfied with Chief Executive Officer Robert McDonald’s performance discussing a possible leadership change, according to people familiar with the situation who asked not to be identified because the matter is private.

The company’s board said yesterday that it unanimously supports McDonald and his plan to improve the company’s results. Paul Fox, a spokesman for P&G, declined to comment on future corporate actions.


P&G Stake

The company’s debt has returned 3.37 percent this year through July 11, versus 5.01 percent for all AA corporate securities, according to Barclays Plc index data. P&G is rated Aa3 by Moody’s Investors Service and an equivalent AA- at Standard & Poor’s. Unilever is one level lower, A1 by Moody’s and A+ at S&P.

Ackman didn’t respond to requests for comment on how P&G should increase shareholder value. He revealed at the Delivering Alpha conference produced by television station CNBC and Institutional Investor Inc. in New York yesterday that his fund owns $1.8 billion of the company’s shares.

The 46-year-old Ackman is known for investing in companies he deems undervalued and urging changes he says will improve shareholder returns.

He purchased a stake in McDonald’s Corp. in 2005 and helped pressure the world’s largest restaurant chain to boost its dividend by 50 percent in September 2007. The investor also helped to successfully persuade Wendy’s International Inc. to spin off its Tim Hortons Inc. doughnut business in 2006, leading Standard & Poor’s to cut Wendy’s credit rating to junk.

After Target Corp. rejected Ackman’s suggestion to spin off the land beneath its stores as a publicly traded real estate investment trust, the second-largest U.S. discount retailer behind Wal-Mart Stores Inc. said it favored selling its credit-card business, which Ackman supported. The chain also sold $4 billion of bonds to raise funds for stock buybacks he’d sought.

P&G could borrow $20 billion to repurchase stock and probably still remain “a strong investment grade credit,” Gimme Credit analyst Carol Levenson said in an e-mail message. Ackman’s stake signals that the “pressure to do some kind of financial engineering is nearly inevitable, and nine times out of ten this would be negative for bondholders,” she said.

The company suspended stock repurchases after it said it spent $2.3 billion on its shares in the first calendar quarter.


Undervalued Companies

P&G considers its credit rating important, Chief Financial Officer Jon Moeller said at the Deutsche Bank Consumer Conference on June 20. The company decided to suspend share repurchases to protect itself from downgrades, he said.

“Anytime you get an activist like Ackman involved, then the risks do go up,” said Thomas Chow, a money manager at Delaware Investments in Philadelphia with about $170 billion under management. While Ackman probably will need extra shareholder support to influence management, “the ability of Procter & Gamble to access the market and fund shareholder-oriented activity through the debt markets is probably pretty high,” he said.

Shares of P&G are down 0.4 percent this year including dividend payments, compared with a 10.8 percent gain for the S&P 500 index. The stock has increased 20 percent over the past five years, compared with a 49 percent rise in the 41-member S&P 500 Consumer Staples Sector index.

P&G’s ratio of enterprise value to earnings before interest, taxes, depreciation and amortization of 11.34 times is less than the average of 12.47 among the world’s largest household products makers. Sales growth at the company declined for the third straight quarter to 1.51 percent in the period ended March 31, the slowest pace since 2009.

Market share for the world leader in both hair and laundry care has also declined for two years as Unilever expanded, Bloomberg data show.

“We all know that Procter & Gamble is not performing up to expectations, and patience from shareholders has been wearing thin,” Edward Mui, an analyst at CreditSights Inc. in New York, said in a telephone interview. “When a company moves toward aggressive shareholder-friendly actions, it usually comes at the expense of bondholders, whether it comes in the form of deteriorating credit metrics or asset coverage.”


Cash Use

P&G’s ratio of total debt to Ebitda was 1.8 in the most recent quarter, compared with 1.72 a year ago and 2.4 in 2006, according to data compiled by Bloomberg. Colgate, the world’s largest toothpaste maker, has a ratio of 1.16 with London- and Rotterdam-based Unilever at 1.84 last year, Bloomberg data show.

Bondholders may still benefit from Ackman’s involvement in P&G if he helps spur revenue growth or if management responds to his ideas by divesting brands such as pet-food maker Iams or the Duracell battery unit without handing proceeds directly to shareholders, Mui said.

The extra cash produced by any strategic change probably won’t be used to pay down debt, according to Mark Pibl, head of credit strategy at broker-dealer Cortview Capital Securities LLC.

“In that respect, it hurts the credit,” he said.


Bloomberg News'


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